TECHNOLOGY

TECHNOLOGY; A Surprise From Amazon: Its First Profit

By SAUL HANSELL

Published: January 23, 2002

After losing $2.8 billion since it was founded in 1995, the online retailer Amazon.com said yesterday that it had made its first quarterly profit, $5 million, validating at least in part its strategy to grow rapidly first and worry about profits later.

Amazon's financial results were far better than expected because a yearlong efficiency drive sharply cut costs even as sales grew. An accounting gain related to the decline of the euro's value provided a final push. So the company was able to show a profit by the conventional standard, rather than merely by the nonstandard ''pro forma'' measures that it and other Internet companies prefer.

''They have brought the company back from the brink and made it viable,'' said Mark Rowen, a Prudential Securities analyst who has long been a critic of Amazon. ''Where the company was a year ago and where it is today is like night and day.''

Jeff Bezos, the company's founder and chief executive, said the biggest surprise had been how quickly customers reacted to the company's decision last summer to offer 30 percent discounts on books costing more than $20.

''It's Adam Smith economics that volume will go up when prices go down,'' he said, ''but we didn't know how fast it would take.''

Mr. Bezos said Amazon expected to continue to cut prices on books and other items as its efficiency increased, taking advantage of a business model that has high fixed costs -- for technology and warehouse space -- but relatively lower incremental costs as volume increases. The company said yesterday that it would offer free shipping for orders over $99.

In the Internet mania from 1998 to 2000, thousands of companies sprang up and tried to copy Amazon's get-big-fast-at-any-cost business model. Most failed because they ran out of money before they could break even.

Yet because Amazon started first and borrowed $2 billion to cover its years of losses, it really did get big fast, with $3.1 billion in sales last year. Then it was able to turn to efficiency. Last year it closed two warehouses and eliminated 1,300 full-time jobs, and it used 3,200 fewer temporary workers to handle the holiday rush in 2001 than in 2000.

As a result, Amazon's costs fell 24 percent, even as the number of orders shipped rose 23 percent.

Amazon posted a profit according to generally accepted accounting principles, in addition to the customized pro forma measures that Amazon prefers that investors look at.

The pro forma numbers for the company exclude the cost of severance and other restructuring moves and other items that do not immediately affect Amazon's cash positions.

A year ago, Amazon promised investors that it would show a pro forma operating profit for the fourth quarter of 2001. Using operating profit as a standard is an even more lenient hurdle than pro forma net profit because it does not include Amazon's debt payment of $35 million a quarter. But Amazon did so well that it made a profit by all of these standards.

The pro forma net profit, which is the one that Wall Street analysts focus on for their estimates, was $35 million, or 9 cents a share, in contrast to a loss of $90 million for the quarter in 2000. Analysts had expected Amazon to lose 7 cents a share by this measure.

The pro forma operating profit, the one that Amazon used for its target, was $59 million, compared with a loss of $60 million a year earlier.

And the profit by generally accepted standards was $5 million, or a penny a share. In the quarter in 2000, Amazon lost $545 million by that measure.

But Amazon made a profit only because it had to record a $16 million gain related to debt it had raised denominated in euros. Since the value of the euro fell in the quarter, Amazon will need fewer dollars to repay the debt, and the accountants forced the company to record a gain. But Amazon does not have to repay the debt until 2009 so the practical effect of the fluctuation of the euro on Amazon's finances today is modest.

Amazon will have to cut its profits if its stock price goes up because of rules related to Amazon's decision to replace its employees' stock options, which were granted at times when its stock was soaring, with new ones set at a much lower price. For example, Amazon's shares rose by $2.44 yesterday, to $12.60. By itself, that move would knock $29 million off its reported profit for this quarter.

For the current year, Amazon picked a new goal that moves it closer to sustained profitability but nonetheless is not a conventional profit. The company said that for all of 2002, it would generate positive operating cash flow; that essentially means that money going into the company will exceed money going out, except for capital expenditures.

For 2001, the company had a negative operating cash flow of $120 million. As a result, the company had $997 million in cash at year's end, down from $1.1 billion a year earlier.

In the fourth quarter of 2001, Amazon's sales grew 15 percent, to $1.12 billion. Amazon says it expects sales to grow this year by more than 10 percent. Analysts are worried that growth has nonetheless slowed too much, especially for Amazon's electronics business, once hailed as the key to the company's growth.

Now Amazon is pegging its hopes on deals to run Web sites and warehouses for other companies, like its current deals with Toys ''R'' Us and Target. But revenue from this area increased only 2 percent in the quarter, to $98 million, compared with 2000.

''Most of the outperformance they had this quarter was the book business and international, which is mainly books,'' Mr. Rowen said. ''It still remains to be proven whether they can be a general merchandise retailer.''